In our last lesson we wrapped up our discussion on the different order types available to forex traders with a look at the Entry order. In today’s lesson we are going to continue our discussion on the logistics of forex with a look at something which is known as rollover.
What you are actually trading in the forex market is a contract which requires one currency to be exchanged for another and delivered in two business days. For example, if I buy 1 contract of EUR/JPY then I am buying 100,000 worth of Euros and selling the equivalent amount of Japanese Yen. This technically requires me to deliver the equivalent amount of Japanese Yen portion of the trade to the bank account of the party I am trading with. The party that I am trading with is then technically required to deliver the 100,000 EUR portion of the trade to my bank account in two business days.
As we are trading simply for speculation however, we do not want actual physical delivery of the currency, so the platform which we are using in our examples, and pretty much any other retail forex trading platform, will automatically role this position over to the next delivery date if the position is held past 5pm Eastern Standard Time.
It is not really important to understand all the details here as this part is done automatically. What it is important to understand however is that there is a US Dollar debit or credit made to your account for any position held past 5pm Eastern Time, to account for the interest portion of the transaction.
As with most other transactions which involve holding or borrowing money, trading currencies also involves an interest payment or credit depending on whether you are the holder of a currency or the borrower of a currency.
What this means is that if I buy USD/JPY which means I have bought US Dollars and sold Japanese Yen, then I earn interest on the US Dollars I have bought and pay interest on the Japanese Yen that I have sold in order to buy those US Dollars. The reason for this is technically what I am doing when I sell a currency, is borrowing that currency and then exchanging the borrowed currency for the equivalent amount of the currency that I am buying.
I am oversimplifying things a bit here but basically the interest rates that you pay and receive on the currencies involved in the trade, is two days worth of interest derived from the overnight interest rates of the countries whose currencies you are trading.
If you remember from module 8 of our basics of trading course in the free course section of InformedTrades.com, overnight interest rates in the United States for US Dollars are set by the Federal Reserve. Just as the United States has the Federal Reserve, other countries around the world also have central banks which set the overnight rates for their currencies.
When trading forex if you buy the currency with the higher interest rate and sell the currency with the lower interest rate, then you earn money for holding a trade past 5pm when rollover occurs, because the interest rate differential is in your favor. Conversely if you sell the currency with the higher interest rate and buy the currency with the lower interest rate then you pay interest if you hold the trade past 5pm, because the interest rate differential is not in your favor. If you open and close the position before 5pm then nothing happens as there is no rollovernecessary.
As noted above we are trading a 2 day contract in the forex market, so the interest that you either pay or receive at rollover is 2 days worth of interest, calculated based on the interest rates as set by the central banks in the countries of the currency pairs which you are trading.
Using our USD/JPY trade as an example, overnight interest rates in the United States are at 2.25% as of this lesson, and rates in Japan are at .5%.
As you can see here when we are trading the USD/JPY currency pair, if we buy then we are long (holding) US Dollars at an interest rate of 2.25% and we are short (borrowed) Japanese Yen at an interest rate of .5%. So in this example the interest rate differential is in our favor by 1.75%, so we will earn interest if we hold this position past 5pm NY Time.
If we were to sell the USD/JPY then we are short (borrowing) US Dollars at an interest rate of 2.25% and long (holding) JPY at an interest rate of .5%. So in this case the interest rate differential is against us by 1.75% so we will pay interest if we hold this position past 5pm NY Time.
I have tried to make this as simple as possible but to be upfront this is probably the most difficult concept for traders who are new to the forex
Thats our lesson for today. In tomorrow's lesson we are going to continue our rollover discussion with a look at where you go to find out whether you are going to pay or receive money for holding positions past rollover and the basics of how traders leverage this rollover concept to their advantage so we hope to see you in that lesson.
As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading! market to grasp, so if it takes a little bit of time don't worry you are not alone.
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WEEKLY Forex Economic Calendar: 24 Jan Tue
09:30 GB- Brexit Court Ruling
15:00 US- Existing Homes Sales 25 Jan Wed
00:30 AU- CPI
09:00 DE- IFO Survey
15:30 US- Crude 26 Jan Thu
09:30 GB- GDP
13:30 US- Weekly Jobless
14:45 US- flash Service PMI
15:00 US- New Homes Sales
23:30 JP- CPI 27-Jan Fri
13:30 US- Durable Goods
13:30 US- GDP
15:00 US- University of Michigan
Markets are digesting the U.K. Supreme Court ruling today, which upheld a lower court saying that Parlimentary approval is needed for the Prime Minister to invoke Article 50, which puts the U.K. exit from the EU into motion. The Court also ruled that the approval of the devolved Parliaments in Scotland, Wales and Northern Ireland was not required. So Parliament will have to pass a law invoking EU article 50. There is no worry that this should impact PM May's end of March deadline for Brexit.
If approval of the devolved parliaments had been required, this could have become a messy proceess with Scotland opposing Brexit.
Late Monday U.S. Treasury Secretary-designate Mnuchin muddied the waters when he said that an excessively strong US dollar may be negative in the short term. This report sent the USD lower. Details of the Trump dollar policy are awaited. Use the EURUSD 1.0700 line as a key benchmark of USD strength or weakness.
The U.S. economic calendar today includes: flash Markit PMI, Existing Homes Sales and the Richmond Fed Survey.
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